The DAO Treasurer Series: Part 1 — Fundamentals
In the current crypto ecosystem, there are numerous DAOs popping up daily who are unequipped to handle the challenges they face as DAO managers. There are a few mature DAOs that have figured this out and produce regular reporting for their communities and shareholders to analyze and appreciate, but this is not the norm. Most are at a point where they have voting DAO tokens and potential developers and contributors in addition to members, but the mechanics of paying and running the DAO are still quite rough. Over the next series of articles we will deep dive into some fundamentals of treasury, why active treasury management is important, and some best practices, tools and benchmarking to help your DAO approach treasury management like a pro.
Just like Any organization though, we should always have a set of standards and practices that help manage the finances — and in crypto this is especially true. After all, crypto is a currency or tokenized financial system itself, and so general treasury and corporate finance are not nice to haves for DAOs, they are critical and essential for them to run properly and become successful decentralized enterprises.
My Background: I spent 5.5 years as a Treasury Manager / Senior Manager for one of the fastest growing startups in the real estate/co-working industry. I built many of the treasury tools such as cash flow forecasts and statements, FX analysis tools, and intercompany and cross currency lending reporting and analyses. Over my tenure I assisted in the international growth and finance, building the company and its subsidiaries across 40+ countries and 30+ currencies, managing the global portfolio of currencies and cash investments.
Corporate Finance / Accounting / Treasury Basics
Why do DAOs need corporate finance, treasury and accounting?
As mentioned, a DAO is an Enterprise! It just happens that instead of a CEO leading the ship it is a group of decentralized members who all decide the direction of the enterprise. Even if the DAO has no legal status as an entity in a particular country, it still should be thought of as an entity with the core needs of an enterprise. Like any business, a DAO needs human capital (and sometimes physical capital) to support its enterprise and further its revenues and profits. Human capital requires a cost — and hence needs a budget, because the DAO needs to allocate some of its assets (i.e. cash or tokens) to pay for the human capital (contributors, employees, contractors, etc). DAOs may also have costs associated with other suppliers, for things like websites or running nodes, or marketing, and other administrative efforts that supplement the business but are not core revenue providers / contributors. All of these costs also need a budget! Many DAOs currently use the Snapshot app to gather data around proposed ideas and budgets, and this is a great way to start off for the ad hoc projects. But like companies, the DAO and members should consider a regular budgeting process that is used to allocate a portion of the funds and assets owned to cover a particular time frame. The DAO should not just simply think of the budget of a single proposal, but rather think about it as part of the whole, and how that impacts other economic activities the DAO could undertake. By allocating funds to one proposal, you are reducing the amount that can be used for other proposals. As such, budgeting should contemplate the costs outlined of human capital + administration costs together so that there are no liquidity and funding issues. DAOs have different requirements for these costs at different stages in their life cycle, so it may be difficult for a DAO to know exactly how much to budget where, hence why this should be done on a regular basis with flexibility enough to change the allocations in a shifting landscape. In one quarter it may be that marketing is super important because of a recent dApp release, and so more of the budget can be allocated to that cost stream. Or perhaps there is a flurry of proposals to make more dApps that will provide additional revenue, then a larger budget for building and paying contributors is required. These will have ebbs and flows, so flexibility again is important and re-evaluation regularly is the best practice.
With the general budget strategy imposed, now the DAO needs to consider how much of its resources it would like to allocate over the next 3 months, 6 months, year? This is where it is critical to have some basic holdings / balance sheet reporting — to know how much the DAO can actually afford! Without going into huge detail, it should seem obvious now that knowing how much a DAO can afford is critical for it to know how best to spend its resources. Every DAO has limited resources, and as a general economic principle; it should be allocation and spending those resources on projects and proposals that will have the greatest positive economic impact to increase the overall value of the DAO. Here’s where the diversification of DAO treasury funds becomes vital for success. If the DAO has approved a budget of $50k for this quarter, it needs to come up with $50k. If the DAO only owns native tokens, and contributors are willing to receive native tokens for payments of services, then the DAO can pay that directly. But what happens if the token changes value? Then the DAO is left with spending either more or less tokens to each contributor depending on the spot price — a huge FX risk! In addition, many contributors may simply liquidate their tokens received assuming they have costs they need to personally cover. Diversifying the portfolio ahead of the budget becomes a critical component to the treasury management and general operations. It is no doubt a balancing act, we’ll review later in this section, as the DAO should want a good mix of currencies and native tokens to be prepared for the short term liquidity and cash needs, plus setup for the long term success of the project by holding native tokens.
Budget & Liquidity Forecasting
A budget is absolutely necessary for a DAO to function properly. A budget can be quite simple, nothing fancy, and of course the DAO members need to vote and approve the budget. I would recommend a simple spreadsheet or pie chart that summarizes the current total budget (which would be some % of assets, perhaps 15% for the upcoming quarter), and then enumerates spending budgets for categories relevant to the DAO. The budget typically should be only a sub portion of the total Holdings, at least for the current and next 3 quarters. Once the budget is in place for the upcoming quarter / period, the DAO members can now appropriately forecast their liquidity needs. Liquidity forecasting can be very complex, or quite simple. The most conservative liquidity forecast is using the assumption that 100% of the costs will be allocated on the first day of the period, and there will be $0 revenues for the period to cover and reduce those costs. The opposite spectrum is that revenues received will cover 100% of the budgeted costs, however unless the members have extremely high confidence in this forecast, it is highly suggested to assume costs will exceed revenue. Taking the most simple example that 100% of costs are paid at the beginning of the period with no revenue coverage, then the DAO should plan on having 110% of that liquidity available in stable coins or ETH before the period starts (in case costs end up higher than expected). It is also highly recommended to propose and analyze the budget for not just the upcoming period, but 3–4 periods in the future, along with liquidity forecasts for those periods.
Holdings / Balance Sheet
The balance sheet may be just a simple summary of the current holdings of the DAO. If the only asset the DAO owns is its native tokens — boom then the balance sheet is just a single line of those tokens converted to USD on the date you are presenting the BS (typically quarter end). If the DAO owns more tokens, it would be advisable to separate each out on reporting for diversification visibility, but it again is just the USD sum of those tokens / assets (if NFTs are owned by the DAO also). As the DAO becomes more mature and brings on either full time employees or dedicated contributors with arranged salaries, I would advise including those as a liability for the amount owed through the end of the contract. This helps understand what costs are already accounted for so that the net assets (assets — liabilities) number reflects an accurate summary of the resources the DAO has readily available. It also is advisable, to the extent required, that any assets locked over a DAO vesting period are separated: unlocked tokens are “available tokens” and locked ones represented as “restricted tokens subject to vesting”. This also provides a better context for the amount of real liquidity and assets / tokens the DAO has on hand to be used for their liquidity and budget planning.
Treasury Management & Portfolio Diversification
Having set in motion a budget, and members of the DAO creating liquidity forecasting and current holdings reporting, we now need to actually strategize how to accommodate those plans. The Treasury’s role here is not to make any decisions on the budget or forecasts, ideally the members of the DAO have already agreed on those proposals, so the real job of the DAO Treasury is to ensure it has sufficient capital in the necessary currencies for the DAO to execute its plans perfectly. In looking at the liquidity forecast, the Treasury needs to ensure it has sufficient capital, either in the form of stable coins (preferable) or native tokens / other crypto that it can allocate funds to cover the liquidity needs. At my prior company, I built 1 week and 2 week liquidity forecasts every Monday to understand how much cash was needed to run the business that week. We always took a conservative approach assuming the lower statistical bound of revenue receipts that offset the costs (assuming worst case scenario-most spend). In addition, because we were managing entities in over 42 countries and across over 20+ currencies, we needed to take into account the currencies of each underlying subsidiary and its liquidity needs, to ensure our cash portfolio was appropriately diversified to cover all outflows in those currencies, and they were insufficient the using FX tools to convert the excesses of one currency to shortfalls of another. Because of this, I recommend holding sufficient stable and base currencies (ETH/MATIC) for the short term funding needs as these will be most appropriate to actually pay for the costs. Whereas if the Treasury only has the choice to issue native tokens to fund its needs, then it is taking a big risk that the tokens will have the value required by the suppliers, contributors, and employees when they are due payment. This risk can be offset using tools like buying put options to ensure the price of the tokens will be above what is required in cash, however it may be simpler to proactively ensure sufficient stable coins are already in the treasury before costs accrue. There are several ways in which a Treasury can diversify, and we will explore many treasury tools out there in a later Deep Dive (to be published) over Treasury Tools & Best Practices.
The DAO Treasury’s #1 priority is meeting the short term liquidity needs as discussed above, but beyond that they should be planning ways to generate additional liquidity for future periods (based on forecasts and budgets), ensuring the DAO has sufficient capital for longer term planning (and if not strategizing on borrowing or additional investment activities), generating yield on idle balances, and managing crypto risk exposures. Future liquidity planning will typically involve ways to generate additional stable coins either through revenue or other methods like selling covered calls or limit orders — but doing so in a responsible manner in line with the market.
The DAO Treasury should also establish a baseline minimum capital and minimum stable coin portfolio percentage to be maintained at all times. These targets help the DAO navigate the good times and the bad times. Remember, the DAO Treasury isn’t a hedge fund, their main function is to ensure the financial longevity of the DAO — which means reducing risk in exchange for less volatility. Less volatility does mean less upside for token appreciation, but it also means less downside risk which could ruin a DAO overnight. Once a minimum capital amount is decided upon, the Treasury can now identify if there is risk of dropping below that minimum. If this is identified, then the DAO Treasury needs to strategize how to generate additional Long Term Capital — typically in the form of debt (borrowing) or investment (token sales / grants / equity). Capital markets activities are not overnight, so the DAO should be well aware several months in advance of any treasury risks to be well positioned to take action.
Generating yield on idle balances is not a necessary activity, but is one that the Treasury may find useful to generate yield and bring in more assets without building new products or applications. This can be done with yield farms, lending assets, selling covered calls / puts, and a number of other ways that DeFi offers. It can be difficult to leverage idle native tokens, however, depending on the maturity of the DAO. Selling out-of-the-money covered calls is one way to generate up front yield plus additional benefit portfolio diversification (assuming price goes up), because they use the native tokens directly without market selling.
Finally, the Treasury should be consistently managing their crypto balances held. Once the DAO begins generating revenue in non-native tokens, the Treasury needs to determine if the revenues received will be used to pay for expenses (ie stable coin revenue). If, however, revenue is other tokens, like fees from liquidity pooling or mining, then the Treasury should take into consideration how holding these crypto balances impacts their overall risk exposure (or Value at Risk). A Treasury looks to limit its exposures and reduce its value at risk (defined as the value that a portfolio can lose over a given period based on a particular unfavorable move, typically analyzed as 2 standard deviations or a 90th percentile move). That could mean selling currencies that are held but are not core operating, or it could mean holding those tokens because they have an inverse correlation with the rest of the portfolio. This exercise can be quite complex, and again we will deep dive into some best portfolio management practices on how to identify and quantify the risks, and what tools and methods are available for the DAO Treasury to undertake derisking.
Reporting & Operating Currency Considerations
We should establish the currency of general operations — the currency in which all of the financials are reported on. This may not be obvious at first, but when thinking about your DAO, what crypto or fiat currency does it operate and conduct its business in? And if only native tokens are being used now, is that how the members of the DAO actually consider the operations of the DAO or does the DAO think of those tokens in terms of ETH or stable coin value? Every DAO is different — but I would propose that DAOs in general (unless they have a particular reason to deviate) should adopt stable coin or USD as their operating currency.
Why Stable Coins instead of native tokens:
DAOs are Enterprises, and Enterprises need a consistent currency to pay their contributors in, receive revenues in, and pay for other administration efforts
Native DAO tokens are not designed for operations budgets (Apple wouldn’t pay its glass providers in Apple shares even if they wanted that instead of cash!)
DAO Tokens are meant for voting — not paying people
Can be used for some team compensation however
Revenue is generally not based in the DAO voting token, but rather in an assortment of other crypto
Budgeting and forecasting is much simpler with stable coins, whereas native tokens would have to account for potential changes in spot price in the future to forecast (nearly impossible)
Managing Treasury can be a full time task, and DAOs should consider assigning a “Treasurer” as a full time group of individuals dedicated to managing the portfolio and holdings of the DAO.